Asset allocation strategies in the current low interest rate environment

Table of contents

1 INTRODUCTION

1.1 BACKGROUND AND PROBLEM STATEMENT

1.2 PURPOSE OF THIS MASTER THESIS

2 THEORETICAL BACKGROUND OF MODERN PORTFOLIO THEORY

2.1 RELATION BETWEEN RISK AND RETURN

2.2 DIVERSIFICATION & EFFICIENT FRONTIER

2.3 THE MEAN-VARIANCE PORTFOLIO AS AN OPTIMUM?

2.4 EFFICIENT MARKET HYPOTHESIS

2.5 EXTENSIONS OF MODERN PORTFOLIO THEORY

2.6 CRITICAL EVALUATION OF MODERN PORTFOLIO THEORY & CAPITAL MARKET THEORY

3 LOW INTEREST RATE ENVIRONMENT AND THE IMPLICATIONS ON INSTITUTIONAL ASSET MANAGEMENT

3.1 OVERVIEW OF ASSET MANAGEMENT

3.2 CAUSES AND IMPLICATIONS OF THE LOW INTEREST RATE ENVIRONMENT

3.3 STATUS QUO OF INSTITUTIONAL ASSET MANAGEMENT

3.3.1 German insurance companies

3.3.2 U.S. Endowment funds

3.4 SELECTED INVESTMENT APPROACHES

3.4.1 Active vs. Passive

3.4.2 Core-Satellite-investing

3.4.3 Risk Parity approach

3.5 DO ALTERNATIVE ASSETS IMPROVE ASSET ALLOCATION OF INSTITUTIONAL INVESTORS?

4 DEVELOPMENT OF A SAMPLE PORTFOLIO FOR AN INSTITUTIONAL INVESTOR

4.1 PRACTICAL IMPLEMENTATION OF THE SAMPLE PORTFOLIO

4.1.1 Investment Summary

4.1.2 Objectives and Limitations

4.1.3 Investment Selection and Benchmarks

4.1.4 Asset Allocation & Portfolio Construction with SmartFolio

4.1.5 Portfolio Management with Netfolio

4.2 PERFORMANCE EVALUATION

4.2.1 Overview of Performance Evaluation

4.2.2 Key Figure-based Analysis

4.2.2.1 Risk-Return Profile

4.2.2.2 Risk and Return Ratios

4.2.3 Performance Analysis in the light of the Development on Capital Markets

4.3 BACKTESTING THE PERFORMANCE

4.4 OVERALL RANKING OF THE PERFORMANCE

4.5 CRITICAL EVALUATION OF THE SAMPLE PORTFOLIO IMPLEMENTATION AND THE METHODOLOGY

5 CONCLUSION AND OUTLOOK

Research Objectives and Key Themes

This thesis examines the asset allocation challenges faced by institutional investors, specifically German life insurance companies, within a prolonged low-interest-rate environment. The primary research question is whether a broadly diversified portfolio—utilizing a risk-based investment approach like Risk Parity and incorporating alternative assets—can provide better risk-adjusted returns and improved portfolio stability compared to traditional, bond-heavy strategies.

• Impact of the low-interest-rate environment on institutional asset management.
• Evaluation of Modern Portfolio Theory (MPT) and its practical limitations.
• Analysis of institutional investment models, including the Yale Endowment Model.
• Implementation of a sample portfolio using a Risk Parity strategy and passive ETF-based investment.
• Comparative performance evaluation against traditional and index-based benchmarks.

Excerpt from the Book

Summary of Chapters

1 INTRODUCTION: Outlines the challenges for institutional investors in a low-interest-rate environment and defines the scope of this master thesis.

2 THEORETICAL BACKGROUND OF MODERN PORTFOLIO THEORY: Discusses the fundamentals of risk, return, and diversification, while critically evaluating the assumptions of MPT and Efficient Market Hypothesis.

3 LOW INTEREST RATE ENVIRONMENT AND THE IMPLICATIONS ON INSTITUTIONAL ASSET MANAGEMENT: Analyzes the macro-financial landscape and current institutional practices, contrasting German insurers with U.S. endowment models.

4 DEVELOPMENT OF A SAMPLE PORTFOLIO FOR AN INSTITUTIONAL INVESTOR: Details the practical creation of a €10 billion sample portfolio using ETFs, Risk Parity strategies, and performance benchmarking.

5 CONCLUSION AND OUTLOOK: Summarizes the research findings regarding portfolio stability and suggests areas for future long-term analysis.

Keywords

Institutional Investors, Asset Allocation, Low Interest Rate Environment, Modern Portfolio Theory, Risk Parity, Alternative Investments, Passive Investing, ETFs, Risk Management, Sharpe Ratio, Portfolio Diversification, German Life Insurers, Yale Endowment Model, Capital Markets, Performance Evaluation.

Frequently Asked Questions

What is the core focus of this Master's thesis?

This thesis focuses on how institutional investors, particularly German life insurance companies, can rethink their asset allocation strategies to generate sufficient returns in a persistently low-interest-rate environment.

What are the primary investment strategies discussed?

The work centers on broad diversification, the use of alternative investments, passive investing via ETFs, and the implementation of a Risk Parity approach.

What is the primary objective of the research?

The goal is to determine if a portfolio incorporating alternative assets and a risk-based strategy can outperform traditional, fixed-income-heavy portfolios while providing superior risk-adjusted returns.

What methodology is used to test these strategies?

The author developed a €10 billion sample portfolio using ETF instruments and conducted both a five-month performance monitoring period and a three-year backtesting analysis against various market benchmarks.

What does the main body of the work cover?

It covers the theoretical foundations of Modern Portfolio Theory, the specific challenges of current capital markets, an analysis of status quo institutional management, and a detailed practical case study of portfolio construction and management.

Which key metrics characterize the study?

Key metrics include the Sharpe ratio for risk-adjusted return comparison, Tracking Error, Value at Risk (VaR), and Treynor Ratio, among others.

Why does the author prioritize ETFs for the sample portfolio?

ETFs are used because they offer low management fees, high transparency, and liquidity, aligning with the thesis's support for passive investment strategies in efficient or semi-efficient markets.

How do the Yale Endowment and German Life Insurer models compare in this thesis?

The thesis contrasts the highly diversified, alternative-asset-heavy strategy of the Yale Endowment with the conservative, bond-heavy strategy typical of German life insurers, highlighting the performance gaps between them.